Fintech Firms Are Taking On the Big Banks, but Can They Win?

Banking has long been viewed as one of the last traditional, old-school, stuck-in-the-past industries. When you think of banking, you might still think of wood-paneled walls and pinstripe suits.

That impression may increasingly be misguided.

If you spend more than 15 minutes with any senior executive of a large bank these days, it is almost impossible not to hear the phrase “fintech” uttered. It is usually spoken with a sense of optimism, but sometimes with a sense of dread.

“Fintech,” of course, is short for financial technology, a catchall for a near-revolution of new technologies aimed at upending parts of the financial world, including payments, wealth management, lending, insurance and currency.

The fintech phrase itself is actually not new — it dates to the late 1980s and early 1990s — though it has taken on a heightened sense of importance and urgency now that it has been embraced by Silicon Valley as the new new thing. An estimated $19 billion of investment poured into the fintech bucket last year, according to Citigroup, up from just $1.8 billion five years earlier.

“The real threat to banks is not from Washington or Brussels but from start-ups all over the country creating interesting fintech start-ups that are chipping away at key parts of their franchise,” said Steve Case, a founder of AOL and an entrepreneur with investments in several fintech businesses, who just wrote a book about the future, “The Third Wave.”

The promise of all these new technologies is to fundamentally disrupt the biggest players in finance. Companies like Stripe, a payments company, hope to become replacements for PayPal and others. Lending Club wants to make getting a loan cheaper and easier. Wealthfront wants to advise you and manage your money from your phone. And, of course, Bitcoin and its many derivatives wants to be the new gold, or better yet, digital cash.

If they succeed, Wall Street as we know it may become an outpost of Palo Alto. According to a Citigroup report last week, fintech may be on the cusp of an “Uber moment,” as Antony Jenkins, the former chief executive of Barclays, predicted last year. Some 800,000 people will have lost their jobs at financial services companies to some of the newly dreamed up software in a decade, the report said. “Roughly 60 to 70 percent of retail banking employees are doing manual-processing-driven jobs,” the report explained. “If all the current manual processing can be replaced by automation, these jobs can disappear or evolve.”

The ripple effects are enormous: Consider not just the employees but the impact on commercial real estate, for example, if banks shut their coveted branches on the corners in major cities.

Others are less convinced. Wall Street denizens like the banking investor J. Christopher Flowers have declared that the fintech frenzy is simply that: hype that defies common sense and will leave a trail of failed companies in its wake.

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Credit...Doug Chayka

A third view may have the highest likelihood of coming true: The big banks, so powerful and yet so anxious about the possibility of being disrupted by the upstarts, will gobble them all up in a spate of mergers and acquisitions that puts the disrupters squarely inside the institutions they were supposed to overtake.

Witness JPMorgan Chase’s recent alliance with OnDeck, an online lending platform for small businesses. Rather than build the technology to squash OnDeck or, worse, let OnDeck’s runaway growth continue unchecked, JPMorgan became OnDeck’s “partner.” It has been couched as an early joint venture. But inside JPMorgan, it’s considered an experiment, a way to gather information and get educated about the nascent fintech lending space, and yes — assuming all goes well — possibly to acquire the company or one of its rivals.

That’s not to say OnDeck will be a willing seller, but given the money sloshing around in the financial services industry, it’s hard to believe that banks won’t be willing to pay big premiums. After all, even the most successful fintech companies are still tiny. OnDeck is worth about $500 million; JPMorgan’s market value is $214 billion.

Indeed, the valuations of fintech companies have recently fallen like those of other private Silicon Valley companies. That has led to speculation about a new round of investment and deal making.

“I’m starting to look at opportunities outside,” Patrick Gauthier, vice president of Amazon Payments, said to CNBC this week at a conference in Europe about the prospect of making acquisitions. “After a number of years where fintech has been a little bit ahead of itself in terms of valuations, things have come back to earth.”

The crucial question for the fintech industry is whether these businesses can grow fast enough while maintaining a disciplined approach and navigating the thicket of regulatory hurdles that very likely will stand in the way. Silicon Valley has long shunned regulated industries, but having conquered so much of the landscape in other industries, it is now turning to finance.

The Office of the Comptroller of the Currency recently said it thought a new regulatory framework needed to be created to help foster innovation among fintech companies while ensuring compliance.

Given that the 2008 financial crisis is still so fresh, it is hard to see the rules loosening too much.

Which perhaps may be the most compelling reason for why there is probably going to be a wave of deals among these companies soon. With the cost of compliance so high and many large institutions already having built an enormous compliance infrastructure — the big banks now employ thousands of lawyers — it will only make sense for smaller upstarts to end up as part of a bigger company.

“Some banks will be smart and figure out how to partner with some of these entrepreneurs or acquire some of these companies or do joint ventures, but if they just think it’s going to stay the way it is, they will be surprised,” Mr. Case added.